Compromising the VAT (again)?

Mr. Sta. Ana is the coordinator of Action for Economic Reforms (AER).  This article was published in the Yellow Pad column of BusinessWorld, March 28, 2005 edition, p. 23.

Policy reformers – politicians or technocrats – often have to struggle
with how to treat a compromise. In a liberal democratic setting where
competing, conflicting interests negotiate and bargain, compromises
become the norm.

This is a difficult and tricky question. Take the piece of legislation
passed during the Fidel Ramos administration that shifted the taxation
of sin products from ad valorem to specific. On paper, an ad valorem
tax is superior to a specific tax in the sense that the former is based
on value and hence captures any price increases.

The move to a specific tax was intended to stop the tax evasion under
the ad valorem system, in which the manufacturer would pass on an
artificially lower price to a dummy.

Hence the value of the product would be lower and lead to less taxes paid.

A specific tax is based on quantity. The tax remains, fixed, and it has
to be adjusted periodically, unless the law contains a provision for
automatic adjustment to inflation.

Alas, the law that Congress passed did not stipulate an indexation to
inflation. The whole idea of generating bigger revenues in a
sustainable manner did not happen. What the reformers thought was a
significant gain in tax policy turned out to be a ruinous victory.

Recently, policy makers attempted to correct this glaring weakness in
the law. The indexation of the tax on sin products was a priority
measure.

But again, there was a compromise. In the end, the law that Congress
passed is not an indexation to inflation. The computation of the new
rates is based on old prices. Thus, the additional revenues to be
gained are far less than the optimal. The optimal amount would have
been about P24 billion, but the compromised law would fetch less than
P9 billion.

The response of the few reformers in Congress to the compromise was
mixed. Representative Lorenzo Tanada III, for one, had some serious
reservations, but he opted to vote for the compromised version, fearing
a rejection would have meant loss of revenues. On the other hand, the
representatives of the progressive party Akbayan took a principled
stand by voting against the compromise.

The proposed legislation on the value-added tax (VAT) is likewise
headed towards a heavily compromised revenue measure. The VAT proposal
has two main features – an increase in the VAT rate from 10% to 12%,
and a broadening of the coverage of VAT.

Reformers are divided over this issue. Mainstream economists have
called for the rate increase to stem the fiscal crisis. Their argument
is simple: the VAT, among the proposed tax measures, has the capacity
to generate the biggest amount of revenues. A two percentage point
increase in the VAT rate is equivalent to P25 billion in additional
revenues.

However, a VAT rate increase shifts the burden of taxation to the poor
and the low-income groups. Action for Economic Reforms (AER) opposes
the rate increase, but it supports the removal of VAT exemptions. AER
has recommended other revenue measures that will be sufficient to
narrow the public sector deficit, even without an increase in the VAT
rate.
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AER argues that the VAT is insensitive to the equity criterion. The
consumption pattern of the poor includes goods covered by the VAT, such
as processed food. It is easy to see that sardines, noodles, margarine,
and the like have penetrated even the remotest barrios, with the poor
relying heavily on such processed food.

Aware of how the VAT can adversely affect the poor, other reformers
such as the group of Milwida Guevara, Solita Monsod, Roberto de Ocampo,
et al. propose a temporary increase in the VAT rate. They favor a
return from the proposed 12% rate to the 10% rate, once the VAT’s
contribution to gross domestic product (GDP), or the VAT-GDP ratio,
reaches 4%.

Supposedly to protect the low-income groups, the House of
Representatives has come out with a version that contains different VAT
rates, with goods consumed by the poor having a lower rate. The problem
with this is that it only makes the VAT system more complex and
difficult to administer. Multi-tiered rates create distortions and
inefficiencies.

It is very disturbing to note that the different VAT measures endorsed
by the Senate and the House of Representatives are riddled with
measures that are inequitable, arbitrary, or hard to enforce. Aside
from the multi-tiered rates, the versions of both Upper and Lower
Houses contain exemptions that favor powerful but narrow interests. In
the Lower House version, the importation or lease of aircraft engine,
equipment, and spare parts of airlines is exempted from the VAT. In the
Senate version, international airline and shipping companies enjoy
zero-rated VAT: Not only are they exempted from the VAT payment but can
even claim tax credits for VAT inputs.

Cooperatives, already privileged with an exemption, get an additional favor of having lending operations exempted from VAT.

The Senate version (in particular, the bill of Sen. Ralph Recto) is
convoluted. For one thing, it contains a provision to reduce the excise
tax rates on diesel, naphtha, fuel oil and unleaded gas. This is plain
populist opportunism. On the contrary, there is a strong argument for
an increase in the excise tax on gasoline, notwithstanding the current
high prices of crude oil. A tax increase is justified to address the
negative externalities – traffic and pollution – arising from the
consumption of gasoline. Besides, compared to prices for the rest of
the world, the price of Philippine gasoline is cheap.

For another thing, the Recto bill wants to increase the corporate
income tax from 32% to 35%. At first blush, it looks progressive. But
given the harsh reality of a culture of tax evasion and a revenue
collection agency that is prone to corruption and inefficiency, said
proposal would not result in substantial revenue gains.

In sum, the VAT measures from both Houses fail the test of simplicity,
equity, efficiency and non-arbitrariness. The proposed VAT amendments
cannot even be considered second-best options. They deserve to be
trashed.

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